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Chapter 21: Bankruptcy Law

21.1 Bankruptcy Law Generally

Bankruptcy law governs the rights and duties of a debtor when he cannot pay his creditors, and the rights of and remedies available to such creditors. Generally, bankruptcy law is concerned with gathering the assets of a debtor in an organized manner, determining what can and cannot be used to pay off the creditors, distributing the assets among the existing creditors, and liquidating or reorganizing the bankruptcy estate (the assets of the debtor that are subject to the court’s jurisdiction). Bankruptcy law is extremely complex and a full discussion would be beyond the scope of this work; what follows is a broad outline of the main principles in the field.

21.2 Key Concepts

Bankruptcy court; federal jurisdiction. In the United States, bankruptcy is permitted by Article 1, Section 8, Clause 4 of the US Constitution[1]; it is thus a matter of federal law regulated by Congress (under Title 11 of the United States Code, or the Bankruptcy Code) rather than by the individual states.[2] Bankruptcy cases are normally filed in US Bankruptcy Courts, which are divisions of the US District Courts.

Bankruptcy estate. The “estate” in a bankruptcy matter is created by the commencement of a bankruptcy action. The estate consists of all of the debtor’s property, with certain exclusions set out in federal statute.[3]

Voluntary and involuntary bankruptcy. Voluntary bankruptcy cases are the most common type of bankruptcy filing in the United States. Voluntary filings are done by the debtor, who petitions the bankruptcy court for protection from creditors and, in the case of companies, assistance liquidating or reorganizing the debtor. Involuntary bankruptcy actions are filed by creditors, who seek to force the commencement of bankruptcy proceedings in the hopes that they will be paid.

Automatic stay. US law imposes an automatic stay that comes into effect at the time a bankruptcy petition is filed; generally, this stay prohibits commencing, enforcing, or appealing judicial or administrative actions and judgments against a debtor for any claim arising before the filing of the petition.[4] There are some narrow exceptions to the automatic stay. Some creditors, particularly secured creditors who have perfected a security interest under UCC Article 9, may be able to get around the protection of the automatic stay by filing a “motion for relief from automatic stay.”

Secured and unsecured creditors. Creditors can have secured (as in a transaction under UCC Article 9) or unsecured (as with most credit card debt) interests in the bankruptcy estate. Generally, secured creditors are paid the full amount of their interest, in the order in which their interests were perfected. Whatever is left over (and very often, nothing is left) is then distributed to the unsecured creditors.

22.3 Types of Bankruptcy Actions

There are six different types of bankruptcy actions, each generally referred to by the chapter of the Bankruptcy Code that authorizes them.

Liquidations. Chapter 7 filings are the most common type of bankruptcy action. In a Chapter 7 case, a trustee is appointed by the court. The trustee collects all of the debtor’s non-exempt property, conducts a sale and distributes the sale proceeds among the creditors. Debtors are normally permitted to keep “essential” property. As a result, many Chapter 7 actions lead to “no asset” cases in which debtors keep all of their property and creditors receive nothing.

Reorganizations. Reorganizations are bankruptcy actions filed under Chapters 9, 11, 12, and 13 of the Bankruptcy Code. These are more complicated than liquidations as they involve the generation of a plan under which debtors keep some or all of their property and are permitted to pay off their creditors using future earnings. Chapter 9 is available only to municipalities such as cities or counties. Chapter 11 actions are most commonly used by business entities, although individuals are permitted to file them. Chapter 12 is available only to family farms or fishermen. Most individual filings for reorganization are under Chapter 13.

Certain types of entities are prohibited to file bankruptcy petitions. These include banks, deposit institutions, railroads, and certain other types of institutions regulated by federal and state law.

22.5 Bankruptcy–Related Crimes

Certain acts relating to bankruptcy petitions are crimes under federal law.[5] For example, filing a bankruptcy petition to defraud a creditor, making a false statement in bankruptcy proceedings, or fraudulently concealing property from the court are all federal crimes. They may also be punishable under relevant state statutes.

Footnotes:

[1] Article 1, Section 8, Clause 4 of the US Constitution provides in relevant part that “Congress shall have power . . . To establish . . . uniform Laws on the subject of Bankruptcies throughout the United States.”